Sidestepping deferred intercompany gain.

• Author: Van Leuven, Mary

It is not uncommon for affiliated groups that file a consolidated U.S. federal income tax return (U.S. consolidated groups) to have gain that has been deferred under the intercompany rules for U.S. consolidated groups. This item illustrates how transfers of items outside a U.S. consolidated group can trigger a deferred intercompany gain (DIG) and suggests ways to avoid that result in certain situations.

Example 1: USS, a U.S. corporation, distributes stock of a foreign subsidiary FS1 to USP, USS's parent corporation, in a distribution not qualifying under Sec. 355. The distributed stock (BIG stock) has a built-in gain. USP then contributes the BIG stock to FS2, a foreign subsidiary of USP, in an exchange quali-fying under Sec. 351. USS and USP are members of the same U.S. consolidated group; FS2 is not a member of the group.

Intercompany Rules Generally

Under Sec. 311(b), when a corporation distributes appreciated property, the corporation generally is required to recognize gain built into the property as if such property were sold to the distributee at its fair market value (FMV).However, there is an exception to the general rule for transactions between corporations that are members of the same U.S. consolidated group immediately after the transaction (intercompany transactions). Generally, any gain realized on an intercompany transaction is deferred in determining the U.S. federal income tax consequences to the selling member until it is required to be included in income under either the matching rule of Regs. Sec. 1.1502-13(c) or the acceleration rule of Regs. Sec. 1.1502-13(d).

In the example transaction, USS and USP are members of the same U.S. consolidated group immediately after the distribution of the BIG stock from USS to USP; therefore, the distribution is an intercompany transaction. Consequently, the gain built into the BIG stock will become a DIG, which should be deferred until the matching rule or the acceleration rule requires it to be included in income.

The Acceleration Rule

Under the acceleration rule, the intercompany items of a selling member (S) are taken into account immediately before the items can no longer be taken into account to produce the effect of treating S and the buying member (B) as divisions of a single corporation. Regs. Sec. 1.1502-13(d)(1)(i) explains that, for this purpose, the effect cannot be achieved to the extent a non-member reflects, directly or indirectly, any aspect of the intercompany transaction, e.g., if B's cost basis in property purchased from S is reflected by a nonmember under Sec. 362 following a Sec. 351 transaction.

An outbound transfer could trigger the recognition of a DIG under the acceleration rule when, for example, the transfer results in a...